12/12/08

Market Report #2

Well we can't just gloss over the news this morning that the US Senate, at least for now, has rejected the 14 Billion dollar cash infusion of our three big automotive companies. It will be interesting to see if the Whitehouse decides to sidestep that small detail and withdraw the money from the "TARP" funds, that were theoretically allotted to bank and financial institutions, mortgage related affairs etc. The TARP funds have already blown through $335 Billion of the $700 Billion, so that remaining money will be held pretty tightly in my opinion.

At this point it looks like either the Federal Reserve will have to step in with funds, the TARP money gets diverted to cover the money, or the companies file for bankruptcy. Some people argue that the airlines have worked through bankruptcy filings and the car companies also could do this. BUT, it is one thing gambling on buying a ticket to go somewhere and gambling that a company can function, after you just bought one of the biggest purchases you will make: your car.

First lets look at the TARP funds and how they theoretically affect us.

At this juncture, the head of our Federal Reserve, Henry Paulson, is absolutely against the use of any TARP money to aid the car companies. He maintains that the funds should be used exclusively for the financial sector, because  any financial stability of our economy is based on sound economic institutions. Obviously we learned that from the Great Depression, when the nation's banks collapsed.

Critics say that the major 11 US banks and financial institutions, which have each received a mandatory 25 Billion dollar infusion from the TARP funds, have not trickled the funds out to help small business or individuals. They are being accused of hoarding the funds (and honestly at this point who could blame them, it might be the last money they get).

According to one of the major recipients of the funds, JPMorgan Chase Bank, money is being sent out. Speaking on CNBC yesterday, Jamie Dimon,  Chairman of the Board and Chief Executive Officer
of JPMorgan Chase, maintained
each loan needs to be done so that they know it can result in a positive investment. You can't argue with that point, it was that non scrutiny policy that got us all here in the first place. He maintains that today there is way more intrabank lending, credit card lending etc. and they have set up many extra offices to work on mortgage renegotiations of payoff terms, interest rates, etc.

 Jamie Dimon orchestrated the takeover of Washington Mutual and Bear Stearns this past year after both institutions were on their way to bankruptcy.

What does this have to do with us? Plenty!

At this point the major banks in the US are JP Morgan Chase, Bank of America, and Wells Fargo. We all need these banks to be successful or we won't have access to any money to keep cash flow going to pay our bills , while we earn money. If they tighten up and reduce credit lines on credit cards, increase interest rates on credit cards, cancel credit cards, and don't do auto loans, lines of credit, and home loans, we the American people will be  in a prolonged recession.

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 Here is a short article that rates JP Morgan Chase as the number one bank:

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Strongest U.S. bank? It’s not B of A or Wells Fargo, analyst says

(Reuters)—Banking giants Bank of America and Wells Fargo may need to raise billions of dollars in common equity and face a high risk of a dividend cut, a banking analyst at Atlantic Equities said and downgraded both the stocks.

Analyst Richard Staite lowered his rating on Bank of America to “underweight” from “neutral” and Wells Fargo to “neutral” from “overweight.”

Mr. Staite said J.P. Morgan Chase has the strongest capital ratios—a measure of capital strength that investors are closely watching these days—and is the least likely of the three banks to cut its dividend or raise new equity.

He expects Bank of America and Wells Fargo to raise $15 billion and $10 billion in common equity, respectively, and said their payout ratios could exceed 100 percent in 2009.

“These payout ratios are too high and given the uncertainty of a recovery in 2010 we now think there is a high chance of a dividend cut from both Bank of America and Wells Fargo,” he said.

Bank of America’s acquisition of Merrill Lynch and Wells Fargo’s acquisition of Wachovia have hurt their tangible common equity to tangible asset ratio, thereby making equity raise necessary, Mr. Staite said.

After the acquisitions, Bank of America’s tangible common equity to tangible asset ratio will fall to 3%, while that of Wells Fargo will fall to 2.9%, which are “too low,” the analyst added.

Mr. Staite said capital from the U.S. Treasury’s Troubled Assets Relief Program does not help tangible common equity capital ratios and that it boosts only Tier 1 capital ratio, which is not a not a “good guide” to the risk being faced by common shareholders.

The U.S. Treasury has invested $25 billion at Wells Fargo and $15 billion at Bank of America in October under its financial rescue package.

Bank of America shares, which have been battered by heavy losses and write downs from risky assets, could face yet another decline on concerns about rising credit losses and difficulty in integrating Merrill Lynch, Mr. Staite said.

Shares of Bank of America have shed 59% of their value since the start of the year and touched a multiple-year low of $10.01 on Nov 21, according to Reuters data.

“We set a price target of $15.00 (on Bank of America stock) and recommend switching into J.P. Morgan,” Mr. Staite said

J.P. Morgan’s acquisition of Washington Mutual should be relatively easy to integrate and will increase the company’s market share, particularly in investment banking, the analyst said. He maintained an “overweight” rating on J.P. Morgan shares.

Mr. Staite reduced his fourth-quarter and 2009 profit estimates on all three banks and said a severe recession will extend throughout 2009.

He expects higher credit costs to hurt banks’ earnings in 2009 and 2010, and lower volumes and lower fee income to hit revenue during the period.

“Unlike in previous cycles we do not expect to see an improvement in net interest margins because deposit competition is too intense,” Mr. Staite added.

Mr. Staite expects net charge offs to jump to a total of $66 billion in 2009 from $35 billion in 2008 at Bank of America, Wells Fargo and J.P. Morgan.

“With a dramatic pick up in corporate bankruptcies and rising unemployment the news-flow relating to the large banks will remain very negative,” Mr. Staite said.
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Well, that article wasn't too positive, and the one thing he was positive about the "relatively easy" integration of Washington Mutual into JP Morgan Chase, was dispelled by yesterday's interview with JP Morgan head Jamie Dimon.

Mr. Dimon's approach is to me, is what I always strive to do with VPI-be  conservative and a risk taker at the same time.

What does that mean? JP Morgan did not need to take the $25 Billion of TARP money, but because the government did not want the names of the banks that did need to have the money disclosed (fearing a run on those banks and further instability) JP Morgan was a recipient of the funds. That indicates that the management had been running things way more conservatively as far as leveraging their assets and exposing their company to the mortgage mess like all of the companies that did need the money. Dimon was in the position to take advantage of the downfall of two companies, Bear Stearns and most recently Washington Mutual. Though he has a conservative nature in terms of running his company, he knows opportunity when he sees it and did not hesitate to aquire new companies for future business. He realizes it will not be easy to integrate those companies, but ultimately he would have a big advantage in terms of increased bank branches in places where JP Morgan did not have a big presence. At the same time, I found him quite humble in his interview in terms of realizing getting the job done and the final results he wants is going to be difficult.

The good news to me, and why I am very optimistic about the future is that ANY investment indicates a look toward the future and a rebound in the economy.

I believe that this is a time that companies that are solid, have good cash flow, and an eye to the future will be the ones that will bring us through to the next economic good times.